The Great Barclays debate

U.K. bank insists not all risk is "generic" - but write-down fears remain

By

SimonKennedy

LONDON (MarketWatch) -- With a major investment banking business, exposure to toxic U.S. mortgages and a U.K. loan book that's set to be hit by the economic downturn, Barclays' ability to avoid heavier write-downs and survive without government cash has surprised some investors.

The question analysts and shareholders will hope to see answered when it reports the details of its 2008 earnings on Monday is whether those pitfalls have been effectively dodged, or just postponed.

Certainly the share price indicates the British bank may not be out of the woods.

Collins Stewart analyst Alex Potter said that even if you value the Barclays Capital investment banking arm at zero, the shares are pricing in a 36% chance of the bank being nationalized. Assign a value to BarCap and the implied probability jumps past 50%, Potter said.

Barclays (BARC)
BCS, +4.85%
has repeatedly tried to calm worries over its profit and capital strength. It had some success when it said last month that earnings would be well above the consensus forecast and it wasn't planning to raise any more capital. See archived story.

The shares jumped around 75% in one session after it made that statement, but the stock is still down close to 50% from its highest level in January and has tumbled over 85% from a peak in early 2007.

Barclays said it would report pretax profit for 2008 "well ahead" of the 5.3 billion pound ($7.8 billion) consensus forecast.

"Barclays does remain very high risk just in terms of the size of its balance sheet," said Potter.

'Risk is not generic'

Analysts agree that more detailed disclosures Monday on the bank's 1.4 trillion pound of assets could help settle the argument, but opinions are mixed on how healthy a picture they might paint.

One analyst who didn't want to be named calculated that the bank's disclosure of 5 billion pounds of net write-downs for 2008 suggests the net charge in the fourth quarter was around 1.8 billion pounds -- which would give weight to the view that more write-downs might be needed.

Barclays, however, has continually argued that "risk is not generic" and that not all commercial mortgages or subprime assets will generate the same level of losses.

Collins Stewart's Potter said that if Barclays were to mark down its subprime, Alt-A and commercial mortgages by the same degree as Deutsche Bank
DB, -1.77%
(514000), it would be facing another 4.5 billion pounds of losses.

But he added the marks Barclays has taken remain reasonable when compared to most other peers.

And even if more write-downs are needed, they would have to reach around twice the total net charge for 2008 before they triggered another rights issue or possible nationalization, Potter said.

"A further 10 billion pounds of 2009 write-downs appears to imply the credit crunch doubling in severity this year. This appears a very bearish position," he added.

Credit downgrades

Credit rating agency Moody's Investors Service is expecting more write-downs and earlier this month cut its long-term rating on Barclays by two notches to Aa3 from Aa1 and also lowered its view of the banks overall financial strength to C from B, with the possibility of a further downgrade.

"The downgrades reflect Moody's expectation of potentially significant further losses at Barclays as a result of write-downs on credit market exposures as well as an increase in impairments in the U.K.," the rating agency said.

In particular it's concerned about 10.3 billion pounds of exposure to commercial mortgages and the notional 23 billion pounds of exposure to bond insurers -- which it said could require "a sharp increase in provisioning."

In addition, the acquisition of Lehman Brothers' North American business will further increase the proportion of revenue coming from high-volatility capital markets activities, it added.

Fellow credit rating agency Fitch Ratings also downgraded Barclays recently, to AA- from AA, saying the ambitions of Barclays President Bob Diamond's BarCap investment banking business expose the bank to greater risks and earnings volatility than is appropriate for its previous rating.

Fitch also fears that capitalization could come under further pressure as the level of risk rises and asset quality deteriorates further.

Balance sheet growing

The bank has raised raise over 7 billion pounds late last year, largely from investors in the Middle East, but if it need to raise cash again analysts were uncertain whether it would be able to tap these sources again, or would have to seek government aid.

Asheefa Sarangi, an analyst at Societe Generale, said the Lehman acquisition, along with organic growth in the BarCap business and the weak British pound, could all contribute to a sharp increase in the size of the balance sheet -- potentially rising more than 25% from a year earlier.

"We also believe that the bank may have pursued organic growth more aggressively than we had anticipated," he said.

"We are of the opinion that greater than 25% balance sheet growth and rising leverage during a period when banks are focused on de-leveraging and operating environments are rapidly deteriorating could prove a handicap, rather than a virtue."

Asset growth on that scale could effectively cancel out the majority of the positive impact from the recent capital raising, making a further capital increase a possibility, Sarangi said.

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